A Powerful Incentive
Both Canada and the United States provide special incentives for companies engaged in qualifying R&D activities. However, the Canadian R&D incentive system is generally considered to be more generous than the equivalent U.S. system.
Canadian Federal R&D Tax Incentives
In Canada, a corporation is eligible to claim investment tax credits for qualifying expenditures on scientific research and experimental development (SR&ED). The credit is calculated on actual SR&ED expenditures, and applies to all such expenditures incurred in a given year (not only incremental expenditures). The rates for calculating SR&ED tax credits are as follows:
- For foreign or publicly controlled corporations, credits are calculated at the rate of 20% of qualifying current and capital expenditures.
- For Canadian-controlled private corporations, credits are generally calculated at the rate of 35% on the first C$2 million of eligible current and capital R&D expenditures, and 20% on the balance of eligible R&D expenditures.
Tax credits may be claimed to offset up to 100% of a company's federal income tax liability in a year. Unused credits may be carried forward ten years or carried back three years to reduce federal tax payable in those years. In addition, Canadian-controlled private corporations may be eligible to receive a refund check from the government for some or all of the balance of any credits unused in the current year.
Tax credits claimed in any one year must be included as government assistance in the calculation of taxable income in the following year, thus reducing the effective value of the tax credit.
In addition to income tax credits, the Canadian SR&ED incentives allow qualifying current and capital expenditures to be fully deductible in the year incurred, at the option of the taxpayer. If not required to reduce taxable income in the current year, this tax deduction may be carried forward indefinitely and used to reduce taxable income at any time in the future. This provides an advantage for taxpayers involved in long-term SR&ED projects, as conventional tax losses can only be carried forward for a maximum of seven years.
Three main criteria must be met for activities to qualify as SR&ED:
- Advancement is the discovery of technical knowledge that advances the understanding of scientific relations or technologies. Advancement refers to new knowledge, beyond current industry standards. The advancement criterion may be satisfied even if the attempted advancement is not successful.
- Uncertainty exists if it is not known whether the goals can be achieved, or if it is uncertain which of several alternatives will be successful.
- Content requires a systematic investigation by analysis and experimentation to reach logical conclusions, by persons whose professional skills are commensurate with the requirements of the project.
Provided that the above three criteria are satisfied, four different stages of SR&ED activity may qualify for investment tax credits:
- Basic research - work undertaken for the advancement of scientific knowledge without a specific practical application in view.
- Applied research - work undertaken for the advancement of scientific knowledge with a specific practical application in view.
- Experimental development - work undertaken for the purpose of achieving technological advancement so as to create new or improve existing materials, devices, products or processes.
- Research support - engineering, design, mathematical analysis, operations research, computer programming, data collection, testing, or psychological research work undertaken by (or on behalf of) the taxpayer where the work is directly in support of work described in the other three categories listed above.
In addition to current, direct SR&ED costs, certain overhead expenditures may also qualify for investment tax credits. The taxpayer may elect to calculate credits based on actual overhead costs incurred in respect of SR&ED activities, or by using a simple "proxy" method. In general, the overhead proxy amount is equal to 65% of qualifying salaries and wages paid to employees directly engaged in SR&ED activities. The proxy method provides a simplified calculation, and is usually advantageous in labor intensive SR&ED activities.
Investment tax credits can be claimed in respect of capital equipment where that equipment is intended to be used for all or substantially all (90% or more) of its useful life in SR&ED activities. Where shared-use capital equipment is to be used primarily (50% or more) for SR&ED activities, but fails to meet the "substantial" (90% or more) test, partial investment tax credits may be available.
In general, grants or contract payments received by a corporation from a Canadian resident to fund SR&ED activities reduce or eliminate SR&ED expenditures qualifying for investment tax credits. However, contract payments received from non-residents of Canada are not treated in this manner, and a Canadian corporation can claim tax credits on all qualifying SR&ED expenditures, even if those expenditures are fully-funded under contract from a non-resident corporation. (Source - Business Costs & R&D Incentives For Research Companies In Sarnia-Lambton, MMK Consulting Inc., April 12, 2005)
Real after tax cost of a $100 R&D Expenditure
2009 taxation year |
|
Small and medium-sized non-manufacturers1
(Public, Private or Foreign-owned) |
R&D
Expenditures
($ CDN) |
R&D Expenditures
at Eligible Ontario
Research Institutes2
($ CDN) |
| Gross expenditure |
$100
|
$100.00 |
| Ontario - 10% OITC3 |
($10.00) |
(10.00) |
| Ontario - 20% OBRI tax credit4 |
|
$100.00 |
| Ontario - 4.5% ORDTC5 |
($4.05) |
(10.00) |
| Federal investment tax credit - 20% |
(%17.19) |
$100.00 |
| Tax deduction6 |
|
|
| $68.76 x 33.0% |
($22.69) |
|
| $53.48 x 33.0% |
|
($17.65) |
| After-tax cost of $100 Expenditures |
$46.07 |
$35.83 |
Source - Reviewed by Canada Revenue Agency, Ontario Region: Ministry of Finance, May/June 2008 (9/008)
1 Medium-sized companies have taxable income of less than $400,000 and taxable capital of less than $50 million
2 Eligible Ontario research institutes include universities, colleges of applied arts and technology, research hospitals and other entities in Ontario
3 The 10% refundable Ontario Innovation Tax Credit (OITC) (See below)
4 The 20% refundable Ontario Business Research Institute Tax Credit (OBRITC) (see below)
5 The 4.5% Ontario Research and Development Tax Credit.
6 2009 tax rates for non-manufacturers: Federal 19.0% plus Ontario 14.0% = Total 33.0%.
Other R&D Tax Incentives available in Sarnia-Lambton
In addition to the Canadian federal R&D tax incentives, the government of Ontario also offers two R&D tax incentives:
- Ontario Innovation Tax Credit: small companies in Ontario with net assets of less than C$25 million and taxable income of less than C$250,000 can claim a refundable tax credit equal to 10% of eligible current and 4% of eligible capital R&D expenditures, up to maximum of C$2 million in eligible expenditures.
- Ontario Business-Research Institute Tax Credit: Companies in Ontario can claim a refundable tax credit equal to 20% of amounts paid to research institutes (e.g. universities, hospitals, etc.) under an eligible R&D contract.
Due to the fact that these Ontario R&D tax credits represent government assistance, they must be included as part of taxable income in the year in which the benefit is realized (generally the following taxation year). However, as a further incentive to companies undertaking R&D, Ontario does not require the inclusion in income of any federal R&D tax credits received. Therefore, the effective value of the tax deduction for R&D expenditures allowed in Ontario is reduced only by the value of the Ontario credit received (if any) and not by the value of federal credits.
In addition to these R&D tax credit programs, there are a number of other incentive programs that companies undertaking R&D in Sarnia-Lambton may be able to access. However, these programs are all highly discretionary, and assistance needs to be sought and negotiated on a project-by-project basis:
- Industrial Research Assistance Program (IRAP): This program, administered by the National Research Council (NRC), provides financial assistance, business and technology advice, and a range of other innovation assistance to small and medium-sized Canadian enterprises.
- Natural Sciences and Engineering Research Council of Canada (NSERC): This body can provide research grants for university-based collaborative research projects.
Source - Business Costs & R&D Incentives For Research Companies In Sarnia-Lambton, MMK Consulting Inc., April 12, 2005
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